The number of US hedge funds' selling positions on the dollar surpassed buying ones by a total of 21,567 contracts in mid-April, according to data provided by the Commodity Futures Trading Commission. The greenback is thus poised to slide against its eight major peers for the first time since July 2014, easing the currently rife imbalances in international trade, relieving emerging markets somewhat, and exacerbating disinflationary pressures for Japan, where the yen’s strength is hitting exporters’ competitiveness.
Dollar bulls amongst hedge funds ruled supreme between November 2014, when the collapse in oil prices accelerated amidst the boom in US shale crude output, and December 2015, when the US Federal Reserve hiked their base borrowing costs from 0-0.25% to 0.25-0.5%. At those moments, bullish bets exceeded selling positions by 400,000 contracts, but the high-yielding bond market crash in December, and capital wipeout from stock markets in January, followed by lackluster corporate earnings reports, weak macro data and broader recession speculation, have dramatically cooled demand for the dollar ever since.
While the Federal Reserve is poised to leave rates unchanged, and mainland China’s monetary authorities have abstained from major easing measures, resulting in a steadier FX rate for the renminbi, buying into the US dollar in no longer as profitable as it was throughout 2014-2015. The European Central Bank’s massive stimulus, enacted in 2014, had also rendered the dollar stronger, with the US currency having rallied by 20% between mid-2014 and early 2016. However, as monetary easing policies have all but worn out throughout the world, and there is no sign of tightening policies in the US anytime soon, the dollar is sliding.
“If the Fed is talking about raising interest rates, that puts upward pressure on the dollar,” Jonathan Beinner, international bond trading expert, said. “That feeds back into weakening growth. There’s this negative feedback loop and it’s definitely pointing to a much, much slower tightening cycle in the U.S."
The dollar has declined by 3.6% against its ten major counterparts this year thus far, according to the Bloomberg Dollar Spot Index.
Meanwhile, there is hardly an upside to the broader situation in the US economy, which could have resulted in a new dollar rally. The Q1 earnings of such majors as Alphabet (Google’s owner), Microsoft, and Caterpillar turned out to be a sheer disappointment, and the decline in profits reflected negatively on Wall Street’s performance. Amidst investor anxiety, capital inflow into the real economy is also drying out, rendering US growth slower, while the economy is already balancing on the edge of a recession. Q1 GDP growth is estimated at 0.2% in Q1 compared to 1.4% in Q4 and an average 2.2% throughout 2015.
"There’s no clear driver that I can see that is going to ignite growth in the real economy. We continue to limp along," Kim Forrest of Pittsburgh, PA-based Fort Pitt Capital Group said.
Subsequently, as the dollar is set for further declines, the situation in international trade might gradually roll back to its pre-2014 balance in currency and commodity value. The weaker the dollar, the better the earnings of US-based multinationals, spurring demand for goods and services throughout the globe. However, as many central banks have massively devalued their currencies since mid-2014, the current trade imbalances would be hard to overcome quickly.
“It is central-bank ping pong,” Russ Certo of New York-based Brean Capital said. “They smash it over the net, weaken their currency, and then wait for the next turn.”
Given European Central Bank (ECB) Governing Council member Ewald Nowotny's statement on Friday that negative rates remain vital for fighting disinflation, and the Bank of Japan (BoJ)'s commitment to expand its own negative rates regime, further slides in the euro and the yen are likely. With the dollar weakening as well, investors might consider the higher-yielding emerging markets, particularly if commodity prices rebound.
